Favorable variance definition
/What is a Favorable Variance?
A favorable variance indicates that a business has either generated more revenue than expected or incurred fewer expenses than expected. For an expense, this is the excess of a standard or budgeted amount over the actual amount incurred. When revenue is involved, a favorable variance is when the actual revenue recognized is greater than the standard or budgeted amount.
The reporting of favorable (and unfavorable) variances is a key component of a command and control system, where the budget is the standard upon which performance is judged, and variances from that budget are either rewarded or penalized.
Examples of Favorable Variances
Here are examples of three types of favorable variances:
Revenue variance (sales variance). A retail store expected to generate $50,000 in sales for the month but actually achieved $60,000, resulting in a favorable revenue variance of $10,000. This could be due to increased customer demand, successful marketing campaigns, or higher-than-expected seasonal sales. The extra revenue improves profitability and may indicate a need to adjust sales forecasts.
Cost variance (expense savings variance). A manufacturing company budgeted $30,000 for raw materials, but due to supplier discounts and efficient material usage, it only spent $25,000, leading to a favorable cost variance of $5,000. This reduction in costs directly improves the company's gross profit margin and cash flow. Identifying such savings opportunities helps businesses optimize their spending and increase efficiency.
Labor efficiency variance (productivity variance). A construction firm estimated that a project would take 5,000 labor hours, but workers completed it in 4,500 hours, saving 500 hours and leading to a favorable labor efficiency variance. This could be due to improved workforce productivity, better project planning, or the use of advanced technology. The saved labor costs contribute to overall profitability and improve operational efficiency.
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The Basis for a Favorable Variance
Obtaining a favorable variance (or, for that matter, an unfavorable variance) does not necessarily mean much, since it is based upon a budgeted or standard amount that may not be an indicator of good performance. In particular, favorable variances related to price (such as the labor rate variance and purchase price variance) are only derived from the difference between actual and expected prices paid, and so have no bearing at all on the underlying efficiency of a company's operations.
Favorable Variance vs. Unfavorable Variance
A favorable variance either indicates that revenues were higher than expected, or that expenses were lower than expected. Conversely, an unfavorable variance either indicates that revenues were lower than expected, or that expenses were higher than expected. Managers tend to investigate unfavorable variances in much more detail than favorable ones, on the grounds that these variances must be corrected in order to achieve an organization’s budgeted results.
When to Investigate a Favorable Variance
Budgets and standards are frequently based on politically-derived wrangling to see who can beat their baseline standards or budgets by the largest amount. Consequently, a large favorable variance may have been manufactured by setting an excessively low budget or standard. The one time when you should take note of a favorable (or unfavorable) variance is when it sharply diverges from the historical trend line, and the divergence was not caused by a change in the budget or standard.